Political focus on Bank of Japan is necessary evil

But how lawmakers meddle with central bank’s affairs is crucial

By

V.Phani Kumar

Reuters

HONG KONG (MarketWatch) — Political meddling in monetary policy could be a bitter pill for the Bank of Japan to swallow, but it would be a necessary evil to pull the country out of its long economic stupor, say scholars and economists.

As the BOJ steadfastly sticks to cautious policies, despite numerous calls from politicians and markets to act more boldly, many observers say the mounting pressure on the BOJ is well-deserved and a reasonable response after years of lackluster growth and price declines on its watch.

Some support a change to the Bank of Japan Act to make it more accountable, or even hand the government a greater control over the nation’s monetary policy.

“After so long refusing to contemplate using monetary policy to generate inflation, it will be very hard for the Bank of Japan to change tack with much credibility. For that reason, a change to the BOJ law is sensible,” said Richard Jerram, chief economist at Bank of Singapore.

Such opinions are usually rare in the world of economists and academics, where a central bank’s independence to set interest rates and adjust money supply is extensively recognized as the cornerstone of a sound economic structure and banking system.

A sea of academic research has found that autonomy for the central bank — which is often the lender of last resort and has the authority to print money — is so crucial to maintaining price stability that in its absence, short-term political interests could entrap a nation’s economy and financial systems in the medium- to long-run.

But after three decades of economic stagnation in Japan, some believe the time is ripe for change.

University of Southampton international banking professor Richard Werner, who specializes in research on Bank of Japan and the subject of central-bank independence, is one of the BOJ’s more vocal critics. He believes the BOJ should be “stripped” of its autonomy and returned to the Ministry of Finance’s control.

“The BOJ has, since 1991 when the downturn began, singularly failed to act sufficiently to create a sustainable and sustained recovery. It has, over the many years, been repeating the mantra that it cannot do more to help the economy, which is simply not true,” Werner said.

“The BOJ has preferred to point the finger at other players, such as the government, arguing that further ‘structural reform’ is needed and so on, when clearly the recession is due to a lack of demand, caused by the virtual shutting down of [Japan’s] once thriving banking sector in the 1990s,” he said.

Werner is the author of “Princes of the Yen,” a book on Japan’s central bankers and the transformation of the economy, and has in the past advised the main opposition Liberal Democratic Party on central-bank reform.

Frustration or blame game?

The BOJ, which began operations as Japan’s central bank in October 1882, was reorganized in 1942 under an act of the Japanese Parliament.

Although the Bank of Japan Act was tweaked several times after World War II, it was completely revised in June 1997 — with political support — under the principles of “independence” and “transparency.” The amended law came into effect on April 1, 1998.

The BOJ’s greater independence followed the painful aftermath of the bursting of Japan’s economic bubble in the late 1980s, and against the backdrop of central-bank reform in Europe.

According to economic research at the time by the Japanese think tank NLI Research Institute, the change came around the time in which the U.K. government ceded control over interest rates to the Bank of England, and before the creation of the European Central Bank and the euro.

In the 14 years since the amended law came into force, however, Japanese politicians and the BOJ have often disagreed on monetary policy, with each asking the other to do more to spur an economy that has languished for the better part of three decades.

After years of disagreements with the central bank, politicians from both the ruling and opposition parties now appear to be running out of patience, as measured by a rash of headlines last month.

Yoshimasa Hayashi, acting policy chief at the opposition Liberal Democratic Party (LDP), said in an interview with Dow Jones Newswires that “as a public institution, being independent doesn’t mean it can do whatever it wants to and remain free from responsibility for policy outcomes.”

An LDP panel also suggested a law to give the parliament the authority to fire members of the BOJ’s policy board.

Meanwhile, the junior opposition Your Party has submitted legislation to revise the BOJ law, seeking a greater role for the government over monetary policy and personnel, according to a Nikkei report.

Some forces within the ruling Democratic Party of Japan also appear sympathetic to a change. While Finance Minister Jun Azumi, and Economic and Fiscal Policy Minister Motohisa Furukawa are among those calling for the central bank to do more to boost growth, the DPJ’s policy chief Seiji Maehara said recently that the party would discuss proposed revisions to the law, the Nikkei reported.

Also, two of the nine seats on the BOJ’s policy board are currently vacant, with politicians appearing keen to fill those seats with those favoring further monetary easing. In April, the opposition-controlled upper house of parliament voted down government nominee Ryutaro Kono, chief economist at BNP Paribas, on concerns he might not be aggressive enough about loosening policy.

Still, some doubt politicians will themselves be bold enough to take away the BOJ’s independence, as they wouldn’t want to take responsibility for the nation’s monetary policy.

“A law change is also sensible to emphasize where the ultimate responsibility lies when inflation rises — the politicians have wanted a free rise … [and want] to be able to blame [the BOJ] if things become too unpopular,” said Bank of Singapore’s Jerram.

“This is one of the reasons that nothing happened for 20 years. It is also why I am doubtful that they will amend the BOJ law,” he said.

Inflation and depreciation

After resisting political pressure and defending its independence over the years, the BOJ has lately taken more measures to tackle Japan’s persistent deflation.

In February, for example, it surprised markets by expanding asset purchases and setting a 1% inflation goal in the medium-to-long term.

Then on Friday, it further expanded purchases of Japanese government bonds (JGBs) but still disregarded calls to adopt a hard inflation target — as opposed to its “goal” of 1% at present — and to raise that target to 2%.

The BOJ also said deflation has to be overcome through the collective efforts of corporations, financial institutions and the government, likely suggesting that ending price declines wasn’t solely its responsibility. Read full story on Friday’s BOJ decision.

“The BOJ has to show it is serious. … Such caution leaves the BOJ vulnerable to mounting political pressure. While it is unlikely that the central bank will lose its independence outright, the possibility remains that politicians could provide the BOJ with a legal obligation to meet certain goals, such as a stricter inflation target within a specified time frame,” said Frederic Neumann, co-head of Asian economics at HSBC.

Falling prices and a rising yen are two key reasons for the criticism leveled at the BOJ, as the former amplifies the impact of the nation’s huge debt burden, while the latter undermines Japanese exporters’ global competitiveness.

The yen is currently quite strong compared to historical norms. The dollar is trading around the ¥80 level, compared with about ¥144 in early 1990. The benchmark Nikkei Stock Average (100000018) has lost three-fourths of its value during the same period.

Meanwhile, consumer prices declined or were little changed for 11 of the 13 years between 1999 and 2011, according to government data, aggravating the nation’s debt troubles.

Japan is among the most indebted developed nations on earth, with household, corporate and government debt estimated at 456% of nominal gross domestic product in 2010, according to a Bank of International Settlements report.

Falling prices make debt more difficult to repay, and tend to make business enterprises averse to borrowing for expansion.

The BOJ has often cited the need to tackle the issue of Japan’s rapidly ageing population as crucial to taming deflation. As of October, about 23% of Japan’s population was aged 65 years or more — the highest percentage of seniors in the world — while those aged 15 or below just constituted 13.2%.

How not to intervene

While government intervention in monetary policy wouldn’t be a bad thing in itself, how the politicians do it is seen as crucial.

Kenneth Kuttner, a professor of economics at Williams College, Mass., said there is “nothing inherently wrong with consulting with the government.”

He cited the example of the Bank of England’s inflation target, which is set jointly with the Chancellor of the Exchequer — Britain’s finance minister — and the BOE accountable to the government for any failure to meet the target.

“But having the government direct the specifics of policy — the volume of JGBs to buy, for example — would set a terrible precedent and open the door to all kinds of meddling and micromanaging,” he said.

“Still, being more aggressive certainly wouldn’t hurt, and the risks are low, so why not do it?” he asked.

Most observers agree the BOJ isn’t doing enough to spur the economy, but also point out that the bank isn’t solely responsible for all that ails Japan.

“It is also the government’s responsibility to strengthen the economic foundation. Recent deflation is caused by lack of economic demand, not the reluctance of the BOJ’s monetary policy,” said Junko Nishioka, chief Japan economist at Royal Bank of Scotland.

She said that while the BOJ must enhance its easy policy as long as the yen remains around current levels, taking away its independence would be a mistake, as the government might then devote itself to propping up the labor market without regard for price stability.

HSBC’s Neumann said a key risk is that greater political interference would worry markets that the BOJ “may at some be forced to monetize Japan’s huge public-debt mountain, which could spark a collapse in the faith in the currency.”

Although the BOJ now purchases a greater amount of JGBs, it does that with the intention of providing funds to institutions and has firmly opposed calls for it to directly buy debt issued by the government.

“Its current reluctance to do more stems from the view that monetary easing in itself is ineffective in raising Japan’s growth. However, from a market’s perspective, further monetary easing would still be helpful,” he said.

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